Woodruff Financial Planning blog

Your financial plan is designed to project into the future, so you need to think about how that future will pan out.  With this in mind, you need to make certain assumptions about how certain things will change over time (inflation, investments, expenses etc).  This article describes the areas you should consider, and why they are important.

The Government today proposed to scrap the compulsory retirement age for most employees.  At the moment, it is perfectly legal for an employer to set a compulsory retirement age for its workforce, which can mean that employees can be forced to retire at age 65, whether they want to or not.

This seems unfair and discriminatory. As we live longer, the traditional retirement will no longer apply.  This may mean that some people choose to retire later (working longer), or may semi-retire.  This proposal seems a sensible step in making retirement decisions more flexible, and also allowing employees freedom of choice.

Of course, the reality for many people as they get to retirement age is that they have not done enough to save during their working life, meaning that real hardship could be forced upon them if they are required to retire in the normal way.  This proposal does not remove the problem of a lack of retirement income, but can mean that the over 65s are not forced into poverty.

The consultation period for this proposal ends in October, after which legislation could be brought in to turn this into law from April 2011.

You may have seen that the Financial Services Authority, the UK financial regulator, has today launched the results of its findings into advice given by advisers who recommended unregulated investment schemes.  See here for the report (the results are pretty damning).

This got us to thinking about why regulated investments are generally better than unregulated investments.

So here is a list of some of the main reasons we can think of (feel free to add to the list).

• Risk
  We feel that most unregulated investments are extremely risky, and often invest outside of normal markets.  This is fine if you are a sophisticated and experienced investor, and the unregulated investment forms a small part of your overall portfolio; however, our experience is that most of these schemes are marketed to ‘normal’ investors, who over-expose themselves to this high risk (even borrowing to make the investment). Regulated investments tend to operate in more conventional markets, and usually spread their investments more widely. Regulated investments tend to have a more easily defined risk profile, so you can select the ones most appropriate to your style of investing.
• Controls
  Regulated investments have strict controls and limits on their investment and borrowing powers.  These can be checked before you invest, and need to be approved in advance.  There are requirements for capital security for the underlying investments so that if something goes wrong with the holding company, your assets are protected. This is certainly not the case with unregulated schemes. Also, many unregulated schemes make wild and unsubstantiated claims about their investments, and may not be held to account if these prove false.
• Complexity
  We often find it difficult to understand the complexity of unregulated investments, so we would expect that you would too.  Our general mantra is never to invest in what you cannot understand.
• Liquidity
  Our concern with many unregulated investments is that they could be very difficult to cash in should you need access to your capital. Most regulated investments trade on an exchange, leaving them much more liquid, should you need access to your money.
• Value
  It is much easier to value your regulated investments than with other types of investments.
• Charges
  There is nothing to say that unregulated schemes are more expensive, but this is often the case.
• Due diligence
  Because unregulated schemes are not confined by normal investment regulation, it can be very difficult to drill down into the methodology of the schemes, and how they are structured.  This makes it very difficult for you to understand them, and for advisers to explain them to you.
• The right to cancel
  Regulated investments give you a cancellation period, during which you can change your mind; there is no such right under unregulated schemes.
• Financial Ombudsman
  It is unlikely that the Financial Ombudsman could come to your aid if you have a complaint with an unregulated investment.
• Compensation scheme
  Similarly, it is unlikely that the Financial Services Compensation Scheme would come to your aid if you lost your money.

As with all things involved with investing money, there are no guarantees: always seek the advice of a professional before you take the leap – it is important to consider all your circumstances.

Today, the Government has announced a commission to examine how the country should fund long term care for the elderly.  At present, this is a major issue since this affects thousands of people, who are often forced to sell their homes to fund care in later life.

The Government commission will look into the basis for this funding for the future, and will examine practical proposals such as a State-backed insurance scheme.  We welcome this commission and feel that it is long overdue, since the issue has been largely ignored for many years.  We feel that most people fail to plan for future care needs, hoping that they will not need care.  The reality is that if care is needed, the results can be financially disastrous for the individuals concerned.  To our mind, one of the best ways to ensure a decent level of care for the elderly is to introduce some sort of State involvement, a bit like the NHS.  Whether this is best funded by a payment by the individual, or by general taxation, is up for debate.

The need for long term care funding is summed up by this quote from the Health Minister, Andrew Lansley:

“By 2026, the number of 85 year olds is projected to double.  In the next 20 years we estimate that 1.7 million more people will have a potential care need than today.  We know that one in five 65 year olds today will need care costing more than £50,000, which could force many to sell family homes.”

See here for more information: http://www.dh.gov.uk/en/MediaCentre/Pressreleases/DH_117636

The Government-backed National Savings & Investments (NS&I) has today withdrawn its inflation-linked products from sale.  See here for more information.

These products has been popular in recent months as inflation has risen, and investors sought a safe haven for their savings while most bank accounts offered returns below inflation.

NS&I acknowledges this, commenting that their sales of inflation-linked products were higher than anticipated.

Where does this leave savers looking to beat inflation?
The market for low-risk savings products has been dealt a blow, but there are still opportunities for you to beat inflation with your savings and investments.  If your savings are currently with your bank, I would urge you to revisit this as you may find that you are effectively losing money on your money.  Inflation is currently relatively high, and most accounts pay interest far lower than the increase in prices.

The Financial Services Authority (the body which currently regulates the Financial Services sector), has today launched a consultation paper on Responsible Mortgage Lending.  Their main theme seems to be that “the existing regulatory framework had been ineffective in constraining particularly risky lending and unaffordable borrowing.”

Assessing affordability for mortgages
The FSA rightly says that lenders have been too keen to allow more risky lending in the past.  This has been evidenced with self certification products, as well as ‘fast track’.

Self certification mortgages were originally designed for those people who could not prove their income such as the newly self-employed.  Fast track is still used by many lenders where the loan to value is lower than 75% of the value of the home, and the risk to them is deemed to be low.  Income is still assessed, but documents are not checked.

What ended up happening with these types of loans was that o they became so called “liar loans” – people used the system to inflate their income so that they could justify bigger loans.  Lenders were not concerned about this practice so long as house prices rose.  Of course, eventually this ground to a halt, and the practices were exposed.  Also, many mortgage brokers have been caught out supporting their clients through what is effectively mortgage fraud.

The regulator is concerned that the banks should have more robust methods for establishing affordability for loans. Therefore, they have proposed that all new lending should be assessed for affordability.  This would effectively ban self certified and fast track mortgages.

Interest only
The regulator has been concerned for some time that interest only is becoming much more widespread – probably as a result of the increasing cost of housing.  People have set up loans with no mechanism in place to repay the original capital, and this could end up being a massive problem in the years to come, as they struggle to repay this debt.

The proposal is to assess affordability as if a repayment mortgage is being taken out, even where interest only is the preferred vehicle.  We suspect that the FSA would like to outlaw pure interest only mortgages on main residences, where there is no savings vehicle in place to repay the capital.

Our view
Overall, we would broadly support more responsible lending since this would help to keep the housing market more stable, and encourage the public not to over-extend themselves financially.  We need to get out of the belief that your house is your biggest asset, since this holds back the finances of millions of people who struggle to afford bigger mortgages while ignoring other financial needs.  People need to realise that their home is not an asset in the traditional sense since it cannot be cashed in (you always need somewhere to live).

We have been worried for some time that interest only is becoming the norm, especially in younger buyers.

What all this means for the self employed is that they should seriously consider their lending needs before starting a new business, since in the future it may be very difficult to get funding for such people without full accounts, and enough income to justify the loan.

We recently reported that the Bank of England kept interest rates at 0.5% for another month.  Interest rates have been at this record low point for over a year, so we are concerned that people might get overly confident that these rates are here to stay.  However, this is unlikely as in recent years the average has been somewhere around the 5% mark. See here for more information.

The only way for interest rates is up – so you should think about this if you have a variable rate mortgage or a tracker mortgage.  If you have a fixed rate mortgage, you will be fine during the fixed rate period, but you should also think about the consequences once the fixed rate comes to an end.  Since many households fix for short periods, such as 2 years, this could come around sooner than you realise.

What does an interest rate rise mean for you?
Let’s take a mortgage of £150,000 with 20 years remaining.  If we assume that you are on a standard variable rate with a high street lender, you might be paying 3.5% (this is the Halifax rate based on today’s website).

The table below shows the effect of various interest rate rises, none of which take us up to the 5% rate which is the Bank of England’s ‘normal’ rate.

This information was provided using the calculator at Money Made Clear – an initiative provided by the Consumer Financial Education body.  Click here to put in your own details and work out the effect of interest rate rises on your personal situation.

The message here is clear – you should prepare for future interest rate rises on your mortgage and give some thought as to how you might pay the extra cost if you are on a standard variable rate mortgage.